Hong Kong’s feel-bad tourism

Commentary: Pegged exchange rate poses real problem

HONG KONG (MarketWatch) — In most places, tourism is a welcome boost to the economy. Not in Hong Kong it seems, where a surge in mainland Chinese visitors has led simmering resentment to boil over as local protestors verbally abuse tourists.

The source of frustration is the sheer number of mainland visitors, which is expected to reach 45 million this year, and 70 million by 2017. Any city might struggle to accommodate these numbers, never mind a congested territory of 7 million.

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Furthermore, it’s pretty clear the majority of these visitors are not here to see Hong Kong’s undersized Disneyland but are really traders seeking bargains, courtesy of an outdated exchange-rate regime.

To get a sense of the situation Hong Kong finds itself in, imagine if New York were to have a separate currency and tax regime from the rest of the United States. To replicate the Hong Kong situation, New York would have both significantly lower taxes and a currency pegged at a discount of 25% to the U.S. dollar.

In these circumstances, you might expect half of America to descend on the Big Apple for a shopping bonanza. New York residents would likely be none-too-pleased if they felt they were subsidizing those bargains to non-tax-paying day-trippers.

This is effectively what has happened in Hong Kong as it has accelerated the integration of people and infrastructure with its giant neighbor, while retaining a three decades-old currency peg to the greenback.

While China has re-pegged the yuan higher against the U.S. dollar as its economy has grown, Hong Kong has kept its peg unchanged. In the past six years or so, the rate has gone from 110 yuan for 100 Hong Kong dollars, down to about 78 yuan currently.

This situation means every day seems like a fire sale to mainland visitors who can arbitrage the currency divergence. Now, they are not just buying duty-free luxury goods, but also everyday essentials such as toiletries, which are also cheaper.

The gripe from Hong Kong is that this outsized demand creates shortages, pushes up prices and leads to transport congestion. Among the mainland visitors, about 60% are believed to be same-day visitors, according to Tourism Board estimates.

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Amid these tensions, Hong Kong’s financial secretary is slated to announce his budget for the year this Wednesday, again facing demands to deal with surging costs of living. But he is likely to argue he has limited room for giveaways. It will hardly help to mention that the coffers are depleted due to large infrastructure investments, such as a new high-speed rail link, a bridge to Macau and third airport runway — all to speed more mainland tourists into town.

This mainland tourism furor puts Hong Kong authorities in a tight spot. There is clearly a problem, and to ignore it will lead to more embarrassing protests that will be awkward to explain to Beijing. Taking action to single out mainland Chinese visitors would be highly sensitive.

Already, Hong Kong Chief Executive C.Y. Leung has apparently ruled out putting a cap on mainland visitors. Yet his administration has also acknowledged there is a problem after introducing a controversial stamp-duty hike for non-residents, which was principally designed to curb property buying by mainland Chinese. Hong Kong already imposes curbs on milk-powder sales to such tourists. Both these initiatives have been controversial, as they go against Hong Kong’s traditional free-market ethos.

Yet even the recent stamp-duty policy to tackle property speculation appears to have had limited success, as it has mainly curbed transactions but had a limited impact on prices.

Instead, there have been unintended consequences, as investment money has been diverted into commercial property where there is no stamp duty. This has a knock-on effect, as rents are raised to equate to capital values, which then means restaurants and bars raise prices.

While the seriousness of Hong Kong’s inflation problem can be hard to detect in official figures, there are other signs of stress. One is that many businesses, particularly restaurants and bars, are struggling to fill vacancies. This is perhaps not surprising when inflation means the price of a beer is now often HK$80 ($10.30), while the minimum wage is just HK$30 an hour.

There seems to be no easy fix for Hong Kong’s tourism problem, which to many seems to be inextricably linked to declining living standards.

It should be watched closely as it could bring to head some of Hong Kong’s deep-rooted structural problems and trigger unexpected policy responses. Hong Kong should heed the advice of the former head of its Monetary Authority, Joseph Yam, and look again at the pros and cons of its currency regime.

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